Optimize Inventory for Bottom-line Improvements

by By Nadeem Mazhar On Sep 2, 2008

What role does inventory play in your company's financial health? If you don't know the answer to this question, you may be overspending by up to 12 percent each year on stagnant or outdated inventory.

"When it comes to supply chain management, there is a crucial difference between companies that succeed and companies that fail," according to Nadeem Mazhar, CEO of Custom Technology Solutions LLC, a provider of asset/inventory management solutions. "Successful companies understand the link between inventory management and financial management and treat inventory as a significant asset line item on the balance sheet."

Mazhar identifies three key performance indicators that will provide a snapshot of how well a company is managing its supply chain: the balance sheet, cash flow and EBITDA. Just as company leaders rely on these to indicate overall financial health and viability, they must also include them as signs of sound inventory management.

"Inventory holding costs have a negative impact on overall financial performance, not just operations," he explains.

In short, if you want to correct a drag in your cash flow, a review of your supply chain management practices is as good a place to start as any.

And, company leadership is not the only group seeing a need for balance sheet improvement through inventory management. The shifting economy has led asset-based lenders to scrutinize the composition, quality and velocity of inventory to determine advance rates. In fact, the composition of slow-moving inventory as a percentage of total inventory is becoming a criterion for determining reserves and ineligibility. Companies that fail to grasp the necessity of proactive inventory management will be left with few options.

Broad Benefits

Forecasting and goal-setting are fundamental to companies in every industry, but these activities are traditionally linked to revenue projections and sales. Company leaders must break with tradition and learn to associate these practices with proactive inventory management, as well. And, while it is established that incremental liquidity can impact long-term strategy, many leaders fail to make the connection between the cash tied up in stagnant inventory and the company's ability to execute even short-term or tactical objectives.

"Most people understand how inventory fits as an operating cost, but very few make the connection between inventory and profitable revenue generation," says Mazhar. "Once you cross that bridge, you will open up new avenues of profitability."

A big part of this comes with the ability to link procurement to demand forecast and product velocity, which becomes possible when companies take a proactive approach to asset/inventory management.

Additionally, companies can use sound inventory management techniques to overcome challenges with customer service levels and budgeting, as well as demand and supplier management.

"Just imagine how effective customer service would be if your sales organization had access to accurate and complete inventory data such as fill rates, customers product velocity, and a forecast projections by [stock-keeping unit (SKU)] of their next month's sales at the time of each customer call," proposes Mazhar. "Those indeed would be some very satisfied customers., Helping customers with proactive business intelligence and enabling them to become more agile have mutual benefits for both trading partner, and the benefits in customer loyalty alone can be phenomenal."

Along with satisfaction and loyalty, customer service improvements include on-time and on-quantity delivery, leading to improved forecasting and planning. Collaboration increases as sales and operations teams support each other's efforts to forecast based on demand planning, trend analysis, seasonality and promotional initiatives.

Poor inventory management can be felt at each link in the supply chain. Suppliers, manufacturers, distributors and retailers can all be impacted by the failure to properly address inventory. A point-to-point approach helps optimize inventory each step of the way and ultimately benefits all the players.

With improvements in customer service, as well as collaborative decision support, inventory optimization and balance sheet benefits, there is much to gain and nothing to lose by assessing and correcting supply chain issues. In four to six weeks, a complete system can be up and running and improving both operations and finances.

Case Study: Coni-Seal

Coni-Seal, an after-market automotive supplier, recognized early on how big an impact improper inventory management can have on revenues and overall market share. With inventory levels growing faster than management could track, company leadership could not forecast accurately and could not tie raw material procurement to customer demand. Mazhar's team followed a series of carefully mapped steps to apply a proactive inventory management practice:

Mazhar is quick to point out that right-sizing inventory does not simply mean reducing inventory; it means "buying the right inventory" and taking the time to identify precisely where inventory is out of balance and bringing it under control to minimize uncertainty in purchasing cycles. This also means analyzing buying behaviors, vendor performance and identifying improvement areas, identifying slow and excess inventory, and then establishing a baseline, developing monthly procurement goals which are aligned with the company's financial objectives, developing a report card for measurement, and then committing to a go-forward strategy.

The team implemented a system that automatically downloads inventory, returns and procurement data on a nightly basis. Forecasting methodology then reviews month-to-month history of SKU velocity, aggregate demand and frequency, along with currency of the demand for each SKU. Executive leadership access the system via secure Internet connection to manage inventory, view results, consider system recommendations for product management and make critical planning decisions. To complete the picture, leadership must then measure the effectiveness of the application by viewing key performance indicators, such as gross margins, revenue changes, turns, GMROI, service level and inventory investment level.

"Simply making changes is not enough," advises Mazhar. "Leadership must monitor the results and measure them against hard, financial benchmarks in order to assess the real value of the program."

Coni-Seal implemented a focused inventory management program that achieved the following results in 12 months' time:

A focused inventory management program is a major commitment for any organization. Properly implemented, it can serve as an effective and powerful business tool for operations and forecasting that can achieve real financial benefits in a relatively short period of time.

Implementing this solution requires attention to details that may have been overlooked or simply assumed in the past. Daily assessment of inventory, returns and procurement data are crucial to measuring success. So is monthly assessment of SKU velocity, aggregate demand and frequency, as well as currency of demand data at the SKU level. Finally, executive commitment and action on product management and financial planning are required. Without buy-in at the top level, the process is incomplete and destined for failure.

Once the key pieces are in place and the process has been adopted, inventory managers must faithfully measure those key performance indicators described above, as well as gross margins, revenue changes, turns, GMROI, service level and inventory investment level.

"It sounds like a great deal to manage, and it is," says Mazhar. "But if set up properly, the system can function largely on its own and provide knowledge-based information to the support decision-making process."

And with benefits reaching far and wide into the entire organization, the investment in both time and effort surely proves financially worthwhile in the short and long term.

About the Author:Nadeem Mazhar is CEO of Houston, Texas-based Custom Technology Solutions LLC formed in 1999, which specializes in liquidity, EBITDA, and financial improvement for distribution, manufacturing and retail companies through inventory/asset management. www.ctssys.com. He can be reached at Nadeem@ctssys.com.